What Is the Deposit on a House & How Does It Work?

Buying a home involves several financial steps, and understanding these commitments is an important part of the process. A deposit typically represents one of the initial financial contributions a buyer makes towards a property. This upfront payment signals a buyer’s serious interest in a competitive market, setting the foundation for the transaction.

Understanding the Deposit

A deposit in a home purchase refers to an initial sum of money a buyer provides as a demonstration of serious intent and good faith. This payment is typically made to the seller or a neutral intermediary. It serves to secure the property, taking it off the market and protecting it from other potential offers. For the seller, it provides assurance against a buyer withdrawing without a valid reason. This sum contributes towards the overall purchase price of the home, becoming part of the buyer’s equity upon successful closing.

Key Deposit Types

In real estate transactions, two primary types of deposits are encountered: earnest money and the down payment. Each serves a distinct purpose and is paid at different stages of the home-buying process.

The earnest money deposit acts as a good-faith payment, made by the buyer to demonstrate serious commitment to the seller once an offer is accepted. Its purpose is to secure the property during the contingency period, allowing time for inspections, appraisals, and financing arrangements. This deposit is paid shortly after the offer is accepted and often ranges from 1% to 3% of the home’s purchase price, though in competitive markets, it can be higher, even up to 5% or 10%.

Conversely, the down payment is the initial upfront payment made by the buyer towards the total purchase price of a home, separate from the amount borrowed through a mortgage. This larger sum reduces the loan amount, immediately building equity for the homeowner. It can also reduce or eliminate the need for private mortgage insurance (PMI), a cost associated with conventional loans where less than 20% is put down. The down payment is paid at closing, and its amount varies based on the chosen mortgage program and the buyer’s financial capacity. While earnest money is distinct from the down payment, it is usually credited towards the total down payment or closing costs at closing.

Management of Your Deposit

Deposits made during a home purchase are held by a neutral third party, such as an escrow agent, title company, or real estate attorney. These funds are placed in a secure escrow account, ensuring they are protected until all conditions of the purchase agreement are met. This arrangement prevents either party from unilaterally accessing the funds before the transaction’s terms are fulfilled.

Earnest money is deposited into escrow shortly after the offer is accepted, while the main down payment is transferred at closing. If the home purchase proceeds successfully, the funds held in escrow are applied towards the buyer’s total equity, reducing the remaining amount due for the down payment and closing costs. However, an earnest money deposit may be returned to the buyer if contingencies outlined in the purchase contract, such as satisfactory home inspection results, a successful appraisal, or securing financing, are not met.

Conversely, an earnest money deposit may be forfeited to the seller if the buyer withdraws from the agreement without a valid reason or fails to meet contractual obligations not covered by a contingency. Examples include backing out for non-contingent reasons, failing to meet inspection deadlines, or missing the closing date due to the buyer’s fault. The terms regarding return or forfeiture are detailed within the purchase agreement.

Determining Your Deposit Amount

The amount for both earnest money and down payments is influenced by several factors, including market conditions and loan program requirements. Earnest money deposits range from 1% to 3% of the home’s purchase price, though in competitive markets, buyers might offer a higher percentage, sometimes up to 5% or even 10%.

The down payment amount is dictated by the mortgage loan program chosen by the buyer. Conventional loans can require as little as 3% down for first-time homebuyers, though many lenders prefer 5% or more, with 20% being a common benchmark to avoid private mortgage insurance. Federal Housing Administration (FHA) loans require a minimum down payment of 3.5% for borrowers with a credit score of 580 or higher, or 10% for those with scores between 500 and 579.